Here is another Jack Murray contribution.

Daily Development for Monday, 3/28/05
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

BANKRUPTCY; AUTOMATIC STAY; WAIVER; FORBEARANCE AGREEMENT:  Although automatic-relief-from-stay provision in pre-petition forbearance agreement is not per se enforceable, lender is entitled to enforce agreement unless debtor-borrower can demonstrate sufficient equity in property in excess of mortgage debt, that it is likely it can successfully reorganize, or sufficient prejudice to other creditors to outweigh lender's request for relief.

In re Frye, 2005 Bankr. LEXIS 255 (Bankr. D. Vt. Feb. 24, 2005)

The debtor-mortgagor had filed a prior bankruptcy petition shortly before the expiration of the redemption period in connection with the lender's pending foreclosure proceeding against the secured property (the lender held eight mortgages on various properties owned by the debtor, with a total outstanding indebtedness of approximately $500,000). As consideration for the debtor-mortgagor's agreement to dismiss the bankruptcy, the lender extended the redemption period and the parties entered into a forbearance agreement.  The forbearance agreement provided that if the debtor-mortgagor filed a subsequent bankruptcy proceeding, the lender would be entitled to automatic relief from the bankruptcy stay. The lender agreed twice thereafter to extend the redemption date even further. On the third redemption date, the debtor-mortgagor filed a Chapter 13 bankruptcy case. When the lender sought ex parte relief from the stay in accordance with the Forbearance Agreement the debtor objected, arg uing that enforcement of the lift-stay provision would preclude the debtor-mortgagor from effective bankruptcy relief.

The court noted that a number of courts in other jurisdictions had addressed this issue, with conflicting holdings, but that this was apparently an issue of first impression in the Second Circuit and the District of Vermont. The court reasoned that the facts of two bankruptcy cases in other jurisdictions, In re Shady Grove Tech Ctr. (Maryland1998) and In re Excelsior Henderson Motorcycle Mfg. Co. (Fla. 2002), while not identical to the facts in this case, were sufficiently similar to serve as valid and persuasive precedents.  The court found it significant that, as in this case, the debtor in each of these other cases had entered into a pre-petition agreement, which provided for automatic relief from the bankruptcy stay, in the context of a prior bankruptcy case. The court found (in accordance with the holdings under these other cases) that under such circumstances, the lift-stay language in the forbearance agreement was not against public policy and that, because the forbearance agreement was entered into after the filing of the debtor's first bankruptcy case, "the absence of court confirmation of the Forbearance Agreement does not diminish the applicability of Atrium and Excelsior to the instant dispute."

The court held that while pre-petition agreements waiving the protection of the automatic stay are not self-executing or per se enforceable, they are enforceable if certain factors are present. The court adopted the factors identified by the Atrium court as well as those adopted by several other courts that had addressed this issue; to-wit: (1) the sophistication of the party making the waiver; (2) the consideration for the waiver, including the creditor's risk and the length of time the waiver covers; (3) whether other parties are affected, including unsecured creditors and junior lienholders, (4) the feasibility of the debtor's plan; (5) whether there is evidence that the waiver was obtained by coercion, fraud or mutual mistake of material facts, (6) whether enforcing the agreement will further the legitimate public policy of encouraging out-of-court restructurings and settlements; (7) whether there appears to be a likelihood of reorganization; (8) the extent to which the credit or would be otherwise prejudiced if the waiver is not enforced; (9) the proximity in time between the date of the waiver and the date of the bankruptcy filing and whether there was a compelling change in circumstances during that time; and (10) whether the debtor has equity in the property and the creditor is otherwise entitled to relief from stay.

The court determined, based on its analysis of the body of case law on this topic, that a pre-petition waiver would be enforceable even if the debtor-mortgagor's bankruptcy filing was not in bad faith and even if the debtor-mortgagor had some equity in the property. Applying each of the above-described factors to the facts of the instant case, the court found that they overwhelmingly favored the lender and the enforceability of the lift-stay provision in the forbearance agreement. But the court did not issue a final ruling, instead electing to defer its final determination because evidentiary issues remained as to whether: (1) there was sufficient equity in the property; (2) there was a sufficient likelihood that the debtor-mortgagor's reorganization plan was feasible, and; (3) granting the lender relief from the stay would prejudice other creditors.

Reporter’s Comment 1:  This is a very thoughtful and well-reasoned decision. The court in In re Frye painstakingly examined each of the relevant "factors" and applied them to the facts of this case. Overall, this case should be seen as an important victory for lenders and for the enforceability of pre-petition relief-from-stay waivers - assuming such provisions are contained in documents entered into subsequent to the original mortgage, and  involve actual bargained-for consideration as part of a loan workout or forbearance from the exercise of lender remedies such as foreclosure or the exercise of assignments of rent. It certainly would behoove a lender to pay close attention to the factors listed by the court in In re Frye, because, as the court points out (and other courts have held), such agreements are not self-actuating or per se enforceable.

Reporter’s Comment 2:  Upon the filing of a bankruptcy proceeding, an automatic stay arises by operation of law under Section 362(a) of the Bankruptcy Code.   The stay precludes:

“(1)  the commencement or continuation, including the issuance or employment of process of service, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title; (2)  the enforcement, against the debtor or against property of the estate; of a judgement obtained before the commencement of the case under this title; (3)  any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate; (4)  any act to create, perfect, or enforce any lien against property of the estate . . . .”

Lenders have in the past also attempted to include provisions in loan workout agreements (or even in the original mortgages) that prohibit a borrower from filing bankruptcy.  But the courts have uniformly considered such provisions invalid and unenforceable, as an attempt to obstruct and abridge the jurisdiction of the federal courts and to preclude the ability of a debtor to reorganize.  Also, courts generally have held that pre-petition waivers of bankruptcy benefits, other than the automatic stay, are unenforceable.

Reporter’s Comment 3:  The Bankruptcy Code does not expressly prohibit pre-petition waivers of the automatic stay.  Section 558 of the Bankruptcy Code, however, provides that waivers of defenses subsequent to the filing of the petition are not binding on the estate.

Supporters of pre-petition waivers maintain that enforcement of such provisions is necessary in order to facilitate and effectuate pre-bankruptcy consensual workout arrangements.  They also argue that such agreements are supported by new and valuable consideration in the form of forbearance in the exercise of the lender's legal rights and remedies, as well as other lender concessions and accommodations.

Opponents of these provisions, however, assert that they should not be enforced because they are contrary to the rehabilitative goals of Chapter 11, usurp the authority of bankruptcy judges, and are burdensome to the estate.  Enforcement of such provisions means that the debtor is usually unable to reorganize and must liquidate , thereby leaving little, if any, available assets for distribution to unsecured creditors of the bankruptcy estate.

Reporter’s Comment 4:  It is unclear, as a result of the holdings in the various cases that have dealt with this issue, whether bankruptcy courts will uphold relief-from-stay provisions in the future.  Real estate lenders certainly should be judicious in their use of relief-from-stay provisions in loan workout documents, and may wish to restrict their use and attempted enforcement to true workout situations where the factors described in In re Frye are present. Furthermore, when drafting a relief-from-stay provision, lenders would be well advised to specifically state that the enforcement of the relief-from-stay provision is expressly subject to the approval of the bankruptcy court, in order to avoid the implication that the lender is attempting to oust the bankruptcy court of its jurisdiction and its authority to decide the enforceability of such a provision. See, e.g., In re Sky Group International, Inc. 108 B.R. 86 (Bankr. W.D. Pa. 1989), where the court held that a creditor's unilateral assertion of an automatic right to relief from the bankruptcy stay was a threat to the court's jurisdiction, and must be specifically authorized by the bankruptcy court, which the court emphasized it had no intention of doing in that case.

Reporter’s Comment 5:  As noted in the In re Frye decision, pre-bankruptcy waiver provisions are not self-executing, despite what the language in the provision may provide (e.g., that the automatic stay is automatically lifted upon the filing of the bankruptcy petition).  The lender must file a motion to lift or annul the automatic stay under Section 362 of the Bankruptcy Code, and notice the motion to creditors and parties in interest in the estate. (In Michigan, for example, the applicable local bankruptcy rules provide that such motions are filed on a 15-day notice and opportunity.)  If no objections are filed within the noticing period (e.g., 15 days, plus three days for mailing), a certification of no response is filed seeking entry of the order. On the other hand, if objections to the motion are filed, the court schedules a hearing for determination and resolution of the matter.

Reporter’s Comment 6: The existing body of case law on this issue is still confusing and contradictory -- some courts limit enforcement of such waivers to single-asset real estate cases, and others have held that such waivers are per se enforceable, while still other courts will only enforce the provisions under specified conditions.  As noted by the court in In re Frye, such waivers generally are viewed by the courts on a case-by-case basis and are subject to a review of all the facts and circumstances surrounding the giving of the waiver.  A lender cannot assume, however, that a court will necessarily enforce a waiver of the automatic stay merely as a result of the parties' contractual agreement.  Ultimately, the enforceability of a waiver will depend on the ability of the lender to demonstrate, to the court's satisfaction, that the proper conditions for enforcement exist.

The Reporter for this item was Jack Murray of First American Title Insurance, Chicago Office.

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